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IOSR Journal of Economics and Finance (IOSR-JEF)
e-ISSN: 2321-5933, p-ISSN: 2321-5925.Volume 6, Issue 5. Ver. I (Sep. - Oct. 2015), PP 10-20
www.iosrjournals.org
Abstract: Given the significance of Foreign Direct Investment (FDI) to economic growth and the use of tax
incentives as a strategy among government of various countries to attract FDI, this study examines the influence
of tax incentives in the decision of an investor to locate FDI in Nigeria. Data were drawn from annual statistical
bulletin of the Central Bank of Nigeria and the World Bank World Development Indicators Database. The work
employs a model of multiple regressions using static Error Correction Modelling (ECM) to determine the time
series properties of tax incentives captured by annual tax revenue as a percentage of Gross Domestic Product
(GDP)and FDI. The result showed that FDI response to tax incentives is negatively significant, that is, increase
in tax incentives does not bring about a corresponding increase in FDI. Based on the findings, the paper
recommends, amongst others, that dependence on tax incentives should be reduced and more attention be put on
other incentives strategies such as stable economic reforms and stable political climate.
Keywords: Foreign Direct Investment, Tax Incentives, Nigeria, Economic Growth.
I. Introduction
Empirical and theoretical evidence over decades suggest that FDI is an important source of capital for
investment. It can contribute to Gross Domestic Product (GDP), gross fixed capital formation (total investment
in a host economy) and balance of payments (BOPs) especially when there is good economic conditions in the
host economy such as the level of domestic investment/savings, the mode of entry (merger and acquisitions of
new investments) and the sector involved as well as the host countrys ability to regulate foreign investment
(Toward Earths Summit, 2002).
FDI can complement domestic development effort of host economies by: (a) increasing financial
resources and development; (b) boosting export competitiveness; (c) generating employment opportunities and
strengthening the skill base; (d) protecting the environment and social responsibility; and (e) enhancing
technological capabilities via four basic channels which are the internalization of research and development,
migration of skilled labour, linkages with suppliers or purchasers in the host economies and horizontal linkages
with competing or complementary companies in the same industry (Raian 2004 ; OECD 2002).
On the causal relationship between FDI and growth for three countries - Chile, Malaysia and Thailand
Chaudhury&Mavrotas (2003) found a bi-directional causality running from FDI to GDP (a proxy for growth)
and vice versa. However, the thesis that FDI determines growth was not established in the case of Chile where a
unidirectional relationship was found running from GDP to FDI instead. In support of the above findings,
Alfaro (2003) revisited the impact of FDI on economic growth by examining the role FDI inflows play in
promoting growth in primary, manufacturing and service sectors of 47 countries between 1980 and 1999 and
found that FDI flows into different sectors of the economy and exert different effects on economic growth. FDI
into the primary sector was found to have a negative effect on growth while that of the manufacturing sector
impacted positively on growth.
With regard to less developed countries, macro and micro empirical analysis suggest that overall FDI
have positive impact on economic growth. In many countries FDI constitute the core of the economys growth.
In Bolivia, for instance, Flexner (2000) found that FDI plays a crucial role for a number of reasons: it positively
impacts growth by increasing total investment and improving productivity through diffusion of advanced
technology and managerial skills. A study across developing countries for the period 1990-2000 by (Makola,
2003) showed that FDI was a significant determinant of economic growth across the 12 - case studied
economies and was estimated to be three to six times more efficient than domestic investment. This, according
to (Makola, 2003), is the capacity of FDI to produce a crowding-in effect.
Based on the foregoing, the crucial question then is whether tax incentives is a significant driver of
FDI. Is it possible to stimulate FDI activity significantly using tax incentives or does it have only a minimal
impact on FDI? Or is it possible that the FDI was driven by other political and economic factors besides tax
incentives beyond fiscal control? There is a need therefore, to re-appraise the effectiveness of tax incentives
generally in the promotion of inflow of FDI. As pointed out by Arogundade (2005), factors such as security,
currency convertibility, political stability and market or source of supplies are known to weigh higher on an
investors scale of preferences than fiscal incentives. As he further agued, there is no consensus yet on the role
DOI: 10.9790/5933-06511020 www.iosrjournals.org 10 | Page
Tax Incentives and Foreign Direct Investment in Nigeria
of tax incentives in the decision of a potential investor to locate FDI among different countries. While some feel
that it ranks low, others feel that it significantly influences the location of FDI.
This paper therefore intends to investigate empirically the extent of effectiveness of tax incentives in
attracting FDI in Nigeria within the period 1980-2012. Furthermore, we test the neoclassical investment theorys
prediction that tax incentives lowers the user cost of capital and raises investment holds in an economy.
Empirical studies in this area, in the Nigerian context is scanty. As Arogundade (2005) has observed, there is
need for a review of tax incentive policy in Nigeria as many of these incentive packages have decorated the
statute books for so long without anybody undertaking a survey to determine their effectiveness or continued
relevance. This study intends to fill this gap in the literature. Specifically, the study will provide an overview of
the various steps, tools, aspects and issues relating to tax incentives in Nigeria. It will also provide policy
makers and analyst with a framework to analysing the usefulness of FDI based on the level of growth involved
and suggest reforms to adjust or move towards best practices. Furthermore, it is expected that this study would
provide an indication of, as well as, a guide for further studies. Thus, the empirical evidence provided by the
study will be of great interest both for application and scientific research.
The rest of this paper will be organized as follows: section two reviews literature associated with FDI
and tax incentives in general and in particular for Nigeria. The third section focuses on the research
methodology, section four presents the results and implications and section five provides the conclusion and
recommendations.
III. Methodology
This section is aimed at describing the econometric methodology adopted to analyse the determinants
of FDI and undertakes an empirical assessment of the impacts of tax incentives on FDI in Nigeria. We utilized
econometric data covering the period 1980-2011. We also made use of data on net external FDI inflow, effective
tax rate in Nigeria, GDP, openness to trade, population, exchange rate and inflation (proxies for macroeconomic
stability). The data on FDI, tax revenue and GDP were taken from the Central Bank of Nigeria statistical
bulletin, 2012 while data on exchange rate, inflation rate, population and trade openness were extracted from
World Banks World Development Indicators. The choice of this period is to take into consideration the period
IV. Results
Table 1 (Appendix) presents the descriptive statistics of the main variables used in the analysis. The
table shows that the mean effective tax rate for the period under consideration was 1.76 with standard deviation
of 0.39; that of FDINET was 21.04. Exchange rate and inflation showed a mean value of 60.46 and 20.61 with a
high standard deviation of 61.41 and 18.16 respectively. The mean values for GDP, population, trade openness
and Net flow of FDI in Nigeria were 14.14, 12.25, 3.96 and 21.04 respectively.
Table 2 (Appendix) depicts the correlation matrix showing the degree of correlation between the
variables. FDI is shown to be negatively related to effective tax rate and rate of inflation and positively related
to GDP, population, openness to trade and exchange rate with high degree of correlation of 89, 59, 70 and 83
percent respectively. The correlation matrix depicts that FDI in Nigeria is negatively correlated with tax
incentives to the tune of 44 percent.
Co-integration tests
The summary of Johansson co-integration tests are presented in Table 4 (Appendix). The test rejects
the null hypothesis at 5% level of significance which proves the existence of co-integration relationship among
the variables of the model. This result thus indicates that in the long run, the dependent variables can efficiently
be predicted using the specified independent variables.
Discussion of findings
The model indicates that Net flow of FDI in Nigeria in a particular year is determined by first lag of
FDI in Nigeria and Effective Rate of Taxation although both of these variables had a negative impact on Net
Flow of FDI. This finding is in line with the conclusions arrived at by Mooij&Ederveen (2005), that most
empirical review on the relationship between tax incentives and FDI usually find a negative relationship
between the constructs although with the varied tax elasticity of FDI. It is also in line with the empirical work by
Agodo (1978) for 33 US manufacturing firms as well as findings of Hassett&Hubbard (2002) who averred that
investment incentives create significant distortions thus encouraging inefficient investment. Also, the result of
the study showed that there was no significant impact of trade openness, population, exchange rate, inflation,
and GDP on FDI in Nigeria. The results are thus in line with similar studies such as Nwankwo (2006) and
Babatunde&Adepeju (2012).
The coefficient of determination R2 is 0.641948 (Appendix 6), indicates that about 64 percent of the
total variations in measure of Net flow of FDI are explained by the variations in included independent variables.
This shows that our model explains large proportion of variations in Net flow of FDI in Nigeria. The model also
represents a good measure of fit. The F-statistic shows overall significance of the model. The F-statistic is
significant at 5% level. The results suggest the inflation rate (INF) has the correct sign and is significant at 5%.
More so, the Durbin Watson statistics shows that autocorrelation do not exist between the series of the
model. A unit change in trade openness, rate of exchange and inflation will culminate to an increase of 0.468,
0.0055 and 0.0065 unit change in Net flow of FDI in the short-run. The result further shows that in the short run,
a unit change in the GDP and Population Rate will induce 0.136 and 0.036 reduction in Net flow of FDI but
were not significant.
A crucial parameter in the estimation of the short-run dynamic model is the coefficient of the error-
correction term which measures the speed of adjustment of Net flow of FDI to its equilibrium level. Thus the
speed of adjustment coefficients is negative and significant. This indicates that any deviation from equilibrium
would be adjusted for in the next period at the rate of 52 percent.
References:
[1]. Agodo, O. (1978). The determinants of US private manufacturing investments in Africa.Journal ofInternational Business
Studies,Winter, 95-107
[2]. Action Aid (2012).Tax competition in East Africa a race to the bottom; tax incentives and revenue losses in Tanzania. Policy
Brief Revenue issues among tax incentives in the mining sector. Policy Recommendation
[3]. Adugna, L. &Asefa, S. (2001, August).FDI and uncertainly: Empirical evidence from Africa.International Conference on
Contemporary Development Issues in Ethiopia, Kalamazoo, Michigan.
[4]. Alfaro L.(2003). FDI and growth: Does the sector matter?
[5]. Antwi, S.(2013).Impact of FDI on economic growth: Empirical evidence from Ghana.International Journal of Academic Research
in Accounting, Finance and Management Sciences. 3(1), 18-25.
[6]. Arogundade, J. A. (2005). Nigerian income tax and its international dimension. Ibadan: Spectrum Books Limited
[7]. Babatunde&Adepeju, S. (2012). The impact of TI on FDI in the oil and gas sectors in Nigeria.IOIR Journal of Business and
Management. 6(1), 1-15.
[8]. Barlow, E. &Wender I. (1955). Foreign investment and taxation. Englewood Cliff: Prentice Hall.
APPENDIX
Table 1: Summary of Descriptive Statistics
FDINET GDP POP TOP ETR EXCH INF
Mean 21.04352 14.14275 12.24858 3.964317 1.755627 60.45940 20.60818
Median 20.89775 14.80977 11.62758 4.090468 1.769996 21.88610 13.40762
Maximum 23.25264 17.54061 18.93124 4.404434 2.950764 157.4252 72.83550
Minimum 19.05813 10.77100 11.22286 3.161623 0.494564 0.546400 5.382220
Std. Dev. 1.085557 2.360726 2.147331 0.344786 0.387319 61.40977 18.15888
Skewness 0.207434 -0.115091 2.800474 -1.128111 -0.206746 0.384191 1.538210
Kurtosis 2.324140 1.570779 8.947209 3.264627 7.128935 1.338953 4.093019
Observations 33 33 33 33 33 33 33
Cross-
Method Statistic Prob.** sections Obs
Null: Unit root (assumes common unit root process)
Levin, Lin & Chu t* 0.54264 0.7063 7 221